I 111th CONGRESS 1st Session H. R. 3214 IN THE HOUSE OF REPRESENTATIVES July 14, 2009 Mr. Rooney introduced the following bill; which was referred to the Committee on Financial Services A BILL To provide for credit rating reforms, and for other purposes.

1.

Short title

This Act may be cited as the Rating Accountability and Transparency Enhancement Act of 2009 or the RATE Act.

2.

Findings

Congress finds that— (1)because of the systemic importance of credit ratings and the reliance placed on them by individual and institutional investors and financial regulators, the activities and performances of credit rating agencies, including nationally recognized statistical rating organizations, are the subject of national public interest, as they are central to capital formation, investor confidence, and the efficient performance of the United States economy; (2)credit rating agencies, including nationally recognized statistical rating organizations, play a critical gatekeeper role that is functionally similar to that of securities analysts, who evaluate the quality of securities, and auditors, who review the financial statements of firms, and such role justifies a similar level of public oversight and accountability; (3)because credit rating agencies perform evaluative and analytical services on behalf of clients, their activities are fundamentally commercial in character and should be subject to the same standards of liability and oversight as apply to auditors and securities analysts; (4)in certain of their roles, particularly in advising arrangers of structured financial products on potential ratings of such products, credit rating agencies face conflicts of interest that need to be carefully monitored and that therefore should be addressed explicitly in legislation in order to give clear authority to the Securities and Exchange Commission; (5)in the recent credit crisis, the ratings of structured financial products have proven to be inaccurate, and have contributed to the mismanagement of risks by financial institutions and investors, which impacts the health of the economy in the United States and around the world; and (6)credit rating agencies should determine their ratings independently, without regulatory approval of methodologies, in order to avoid overreliance on ratings and to ensure that the rating agencies, rather than the Securities and Exchange Commission, are accountable for such methodologies, except that regulators should have strong authority to ensure that all other aspects of rating agency activities are designed to ensure the highest quality ratings and accountability for those creating them.

3.

Enhanced regulation of nationally recognized statistical rating organizations

Section 15E of the Securities Exchange Act of 1934 (15 U.S.C. 78o–7) is amended— (1)in subsection (c)— (A)in the second sentence of paragraph (2), by inserting including the requirements of this section, after Notwithstanding any other provision of law,; and (B)by adding at the end the following: (3)

Review of internal controls for determining credit ratings

(A)

In general

Credit ratings by, and the policies, procedures, and methodologies employed by, each nationally recognized statistical rating organization shall be reviewed by the Commission to ensure that— (i)the nationally recognized statistical rating organization has established and documented a system of internal controls for determining credit ratings, taking into consideration such factors as the Commission may prescribe by rule; (ii)the nationally recognized statistical rating organization adheres to such system; and (iii)the public disclosures of the nationally recognized statistical rating organization required under this section about its ratings, methodologies, and procedures are consistent with such system. (B)

Scope of reviews

The Commission shall conduct the reviews required by this paragraph— (i)for all types of credit ratings; and (ii)for new credit ratings, in a timely manner. (C)

Manner and frequency

The Commission shall conduct reviews required by this paragraph in a manner and with a frequency to be determined by the Commission. (4)

Provision of information to the Commission

Each nationally recognized statistical rating organization shall make available and maintain such records and information, for such a period of time, as the Commission may prescribe, by rule, as necessary for the Commission to conduct the reviews under this subsection; ; (2)in subsection (d)— (A)by inserting fine, after censure, each place that term appears; (B)in the subsection heading, by inserting fine, after censure,; (C)in paragraph (4), by striking or at the end; (D)in paragraph (5), by striking the period at the end and inserting ; or; and (E)by adding at the end the following: (6)fails to conduct sufficient surveillance to ensure that credit ratings remain current, accurate, and reliable. ; (3)by amending subsection (h) to read as follows: (h)

Management of Conflicts of interest

(1)

Organization policies and procedures

Each nationally recognized statistical rating organization shall establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of the business of such nationally recognized statistical rating organization and affiliated persons and affiliated companies thereof, to address, manage, and disclose any conflicts of interest that can arise from such business. (2)

Governance improvements at NRSRO

Each nationally recognized statistical rating organization shall establish governance procedures to manage conflicts of interest, consistent with the protection of users of credit ratings, in accordance with rules issued by the Commission pursuant to paragraph (3). (3)

Commission authority

The Commission shall issue final rules to prohibit, or require the management and disclosure of, any conflicts of interest relating to the issuance of credit ratings by a nationally recognized statistical rating organization, including— (A)conflicts of interest relating to the manner in which a nationally recognized statistical rating organization is compensated by the obligor, or any affiliate of the obligor, for issuing credit ratings or providing related services; (B)conflicts of interest relating to the provision of consulting, advisory, or other services by a nationally recognized statistical rating organization, or any person associated with such nationally recognized statistical rating organization, and the obligor, or any affiliate of the obligor; (C)disclosure of business relationships, ownership interests, affiliations of nationally recognized statistical rating organization board members with obligors, or any other financial or personal interests between a nationally recognized statistical rating organization, or any person associated with such nationally recognized statistical rating organization, and the obligor, or any affiliate of the obligor; (D)disclosure of any affiliation of a nationally recognized statistical rating organization, or any person associated with such nationally recognized statistical rating organization, with any person that underwrites securities, entities, or other instruments that are the subject of a credit rating; and (E)any other potential conflict of interest, as the Commission deems necessary or appropriate in the public interest or for the protection of users of credit ratings. (4)

Commission rules

The rules issued by the Commission under paragraph (3) shall include— (A)the establishment of a system of payment for each nationally recognized statistical rating organization that requires that payments are structured to ensure that the nationally recognized statistical rating organization conducts accurate and reliable surveillance of ratings over time, and that incentives for accurate ratings are in place; (B)a prohibition on providing credit ratings for structured products that it advised on, in the form of assistance, advice, consultation, or other aid that preceded its retention by any issuer, underwriter, or placement agent to provide a rating for the securities in question (or any assistance provided after such point for which additional compensation is paid directly or indirectly); (C)requirements that a nationally recognized statistical rating organization disclose any relationship or affiliation described in subparagraphs (C) and (D) of paragraph (3); (D)a requirement that, in each credit rating report issued to the public, a nationally recognized statistical rating organization disclose the type and number of ratings it has provided to the obligor or affiliates of the obligor, including the fees it has billed for the credit rating and aggregate amount of fees in the preceding 2 years that it has billed to the particular obligor or its affiliates; and (E)any other requirement as the Commission deems necessary or appropriate in the public interest, or for the protection of users of credit ratings. (5)

Look-back requirement

(A)

Review by NRSRO

In any case in which an employee of an obligor or an issuer or underwriter of a security or money market instrument was employed by a nationally recognized statistical rating organization and participated in any capacity in determining credit ratings for the obligor or the securities or money market instruments of the issuer during the 1-year period preceding the date of the issuance of the credit rating, the nationally recognized statistical rating organization shall— (i)conduct a review to determine whether any conflicts of interest of such employee influenced the credit rating; and (ii)take action to revise the rating if appropriate, in accordance with such rules as the Commission shall prescribe. (B)

Review by commission

The Commission shall conduct periodic reviews of the look-back policies described in subparagraph (A) and the implementation of such policies at each nationally recognized statistical rating organization to ensure they are appropriately designed and implemented to most effectively eliminate conflicts of interest in this area. (6)

Periodic reviews

(A)

Reviews required

The Commission shall conduct periodic reviews of governance and conflict of interest procedures established under this subsection to determine the effectiveness of such procedures. (B)

Timing of reviews

The Commission shall review and make available to the public the code of ethics and conflict of interest policy of each nationally recognized statistical rating organization— (i)not less frequently than once every 3 years; and (ii)whenever such policies are materially modified or amended. ; (4)by amending subsection (j) to read as follows: (j)

Designation of compliance officer

(1)

In general

Each nationally recognized statistical rating organization shall designate an individual to serve as a compliance officer. (2)

Duties

The compliance officer shall— (A)report directly to the board of the nationally recognized statistical rating organization (or the equivalent thereof) or to the senior officer of the nationally recognized statistical rating organization; and (B)shall— (i)review compliance with policies and procedures to manage conflicts of interest and assess the risk that such compliance (or lack of such compliance) may compromise the integrity of the credit rating process; (ii)review compliance with internal controls with respect to the procedures and methodologies for determining credit ratings, including quantitative and qualitative models used in the rating process, and assess the risk that such compliance with the internal controls (or lack of such compliance) may compromise the integrity and quality of the credit rating process; and (iii)in consultation with the board of the nationally recognized statistical rating organization, a body performing a function similar to that of a board, or the senior officer of the nationally recognized statistical rating organization, resolve any conflicts of interest that may arise; (C)be responsible for administering the policies and procedures required to be established pursuant to this section; and (D)ensure compliance with securities laws and the rules and regulations issued thereunder, including rules promulgated by the Commission pursuant to this section. (3)

Limitations

No compliance officer designated under paragraph (1), may, while serving in such capacity— (A)perform credit ratings; (B)participate in the development of rating methodologies or models; (C)perform marketing or sales functions; or (D)participate in establishing compensation levels, other than for employees working for such officer. (4)

Other Duties

The compliance officer shall establish procedures for the receipt, retention, and treatment of— (A)complaints regarding credit ratings, models, methodologies, and compliance with the securities laws and the policies and procedures required under this section; and (B)confidential, anonymous complaints by employees or users of credit ratings. (5)

Annual reports required

The compliance officer shall annually prepare and sign a report on the compliance of the nationally recognized statistical rating organization with the securities laws and its policies and procedures, including its code of ethics and conflict of interest policies, in accordance with rules prescribed by the Commission. Such compliance report shall accompany the financial reports of the nationally recognized statistical rating organization that are required to be furnished to the Commission pursuant to this section. ; (5)in subsection (k)— (A)by striking , on a confidential basis,; (B)by striking Each nationally and inserting the following: (1)

In general

Each nationally ; and (C)by adding at the end the following: (2)

Exception

The Commission may treat as confidential any item furnished to the Commission under paragraph (1), the publication of which the Commission determines may have a harmful effect on a nationally recognized statistical rating organization. ; (6)by amending subsection (p) to read as follows: (p)

NRSRO regulation

(1)

In general

The Commission shall establish an office that administers the rules of the Commission with respect to the practices of nationally recognized statistical rating organizations in determining ratings, for the protection of users of credit ratings and in the public interest, and to ensure that credit ratings issued by such registrants are accurate and not unduly influenced by conflicts of interest. (2)

Staffing

The office of the Commission established under this subsection shall be staffed sufficiently to carry out fully the requirements of this section. (3)

Rulemaking authority

The Commission shall— (A)establish by rule fines and other penalties for any nationally recognized statistical rating organization that violates the applicable requirements of this title; and (B)issue such rules as may be necessary to carry out this section with respect to nationally recognized statistical rating organizations. (q)

Transparency of ratings performance

(1)

Rulemaking required

The Commission shall, by rule, require that each nationally recognized statistical rating organization shall disclose publicly information on initial ratings and subsequent changes to such ratings for the purpose of providing a gauge of the accuracy of ratings and allowing users of credit ratings to compare performance of ratings by different nationally recognized statistical rating organizations. (2)

Content

The rules of the Commission under this subsection shall require, at a minimum, disclosures that— (A)are comparable among nationally recognized statistical rating organizations, so that users can compare rating performance across rating organizations; (B)are clear and informative for a wide range of investor sophistication; (C)include performance information over a range of years and for a variety of classes of credit ratings, as determined by the Commission; and (D)are published and made freely available by the nationally recognized statistical rating organization, on an easily accessible portion of its website and in written form when requested by users. (r)

Credit ratings methodologies

The Commission shall promulgate rules, for the protection of users of credit ratings and in the public interest, with respect to the procedures and methodologies, including qualitative and quantitative models, used by nationally recognized statistical rating organizations that require each nationally recognized statistical rating organization to— (1)ensure that credit ratings are determined using procedures and methodologies, including qualitative and quantitative models, that are approved by the board of the nationally recognized statistical rating organization, a body performing a function similar to that of a board, or the senior officer of the nationally recognized statistical rating organization, and in accordance with the policies and procedures of the nationally recognized statistical rating organization for developing and modifying credit rating procedures and methodologies; (2)ensure that when major changes to credit rating procedures and methodologies, including to qualitative and quantitative models, are made, that the changes are applied consistently to all credit ratings to which such changed procedures and methodologies apply and, to the extent the changes are made to credit rating surveillance procedures and methodologies, they are applied to current credit ratings within a time period to be determined by the Commission by rule, and that the reason for the change is disclosed publicly; (3)notify users of credit ratings of the version of a procedure or methodology, including a qualitative or quantitative model, used with respect to a particular credit rating; and (4)notify users of credit ratings when a change is made to a procedure or methodology, including to a qualitative or quantitative model, or an error is identified in a procedure or methodology that may result in credit rating actions, and the likelihood of the change resulting in current credit ratings being subject to rating actions. (s)

Transparency of credit rating methodologies and information reviewed

(1)

In general

The Commission shall establish a form, to accompany each rating issued by a nationally recognized statistical rating organization— (A)to disclose information about assumptions underlying credit rating procedures and methodologies, the data that was relied on to determine the credit rating and, where applicable, how the nationally recognized statistical rating organization used servicer or remittance reports, and with what frequency, to conduct surveillance of the credit rating; and (B)that can be made public and used by investors and other users to better understand credit ratings issued in each class of credit rating issued by the nationally recognized statistical rating organization. (2)

Format

The Commission shall ensure that the form established under paragraph (1)— (A)is designed in a user-friendly and helpful manner for users of credit ratings to understand the information contained in the report; and (B)requires the nationally recognized statistical rating organization to provide the appropriate content, as required by paragraph (3). (3)

Content

Each nationally recognized statistical rating organization shall include on the form established under this subsection, along with its ratings— (A)the main assumptions included in constructing procedures and methodologies, including qualitative and quantitative models; (B)the potential shortcomings of the credit ratings, and the types of risks excluded from the credit ratings that the registrant is not commenting on (such as liquidity, market, and other risks); (C)information on the reliability, accuracy, and quality of the data relied on in determining the ultimate credit rating and a statement on the extent to which key data inputs for the credit rating were reliable or limited (including, any limits on the reach of historical data, limits in accessibility to certain documents or other forms of information that would have better informed the credit rating, and the completeness of certain information considered); (D)whether and to what extent third party due diligence services have been utilized, and a description of the information that such third party reviewed in conducting due diligence services; (E)a description of relevant data about any obligor, issuer, security, or money market instrument that was used and relied on for the purpose of determining the credit rating; (F)an explanation or measure of the potential volatility for the rating, including any factors that might lead to a change in the rating, and the extent of the change that might be anticipated under different conditions; and (G)additional information, including conflict of interest information, as may be required by the Commission. (4)

Due diligence services

(A)

Certification required

In any case in which third party due diligence services are employed by a nationally recognized statistical rating organization or an issuer or underwriter, the firm providing the due diligence services shall provide to the nationally recognized statistical rating organization written certification of such due diligence, which shall be subject to review by the Commission. (B)

Format and content

The nationally recognized statistical rating organizations shall establish the appropriate format and content for written certifications required under subparagraph (A), to ensure that providers of due diligence services have conducted a thorough review of data, documentation, and other relevant information necessary for the nationally recognized statistical rating organization to provide an accurate rating. ; and (7)by amending subsection (m) to read as follows: (m)

Accountability

(1)

In general

The enforcement and penalty provisions of this title shall apply to a nationally recognized statistical rating organization in the same manner and to the same extent as such provisions apply to a registered public accounting firm or a securities analyst under the Federal securities laws for statements made by them, and such statements shall not be deemed forward-looking statements for purposes of section 21E. (2)

Rulemaking

The Commission shall issue such rules as may be necessary to carry out this subsection. .

4.

State of mind in private actions

Section 21D(b)(2) of the Securities Exchange Act of 1934 (15 U.S.C. 78u–4(b)(2)) is amended by inserting before the period at the end the following: , except that in the case of an action brought under this title for money damages against a nationally recognized statistical rating organization, it shall be sufficient, for purposes of pleading any required state of mind for purposes of such action, that the complaint shall state with particularity facts giving rise to a strong inference that the nationally recognized statistical rating organization knowingly or recklessly failed either to conduct a reasonable investigation of the rated security with respect to the factual elements relied upon by its own methodology for evaluating credit risk, or to obtain reasonable verification of such factual elements (which verification may be based on a sampling technique that does not amount to an audit) from other sources that it considered to be competent and that were independent of the issuer and underwriter.

5.

Regulations

The Securities and Exchange Commission shall issue final rules and regulations, as required by the amendments made by this Act, not later than 365 days after the date of enactment of this Act.

6.

Study and report

(a)

Study

The Comptroller General of the United States shall undertake a study of— (1)the extent to which rulemaking the Securities and Exchange Commission has carried out the provisions of this Act; (2)the appropriateness of relying on ratings for use in Federal, State, and local securities and banking regulations, including for determining capital requirements; (3)the effect of liability in private actions arising under the Securities Exchange Act of 1934 and the exception added by section 4 of this Act; and (4)alternative means for compensating credit rating agencies that would create incentives for accurate credit ratings and what, if any, statutory changes would be required to permit or facilitate the use of such alternative means of compensation. (b)

Report

Not later than 30 months after the date of enactment of this Act, the Comptroller General shall submit to Congress and the Securities Exchange Commission, a report containing the findings under the study required by subsection (a).